Wednesday, 5 December 2007

Size does matter

In her book "Paradoxes of Prosperity" Diane Coyle notes that "Companies are getting bigger. Or smaller. In between is a bad place to be." The question is why? There seems to be at least two basic forces at work here.

One is globalisation which extends the market for good and services from the national level to the international level. Companies can now rearrange their production and marketing on a world-wide basis which favours huge companies. Some companies can take advantage of economies of scale due to high fixed costs in manufacturing or the marketing benefits of having a global brand like Coca-Cola.

The second force is the expansion of the knowledge economy. As knowledge is most often embedded in people, human capital is becoming more important as a factor of production. The development of ICTs has meant that the costs of moving information embedded in people as opposed to moving information itself have risen sharply. The costs involved in sending and receiving information have fallen thanks to technologies such as email and the Internet along with falls in the costs of long-distance phone calls and the expanding use of cellular networks. The costs of people moving have not fallen however. Commuting to work via congested city and suburban streets, for example, is at least as difficult as it was two decades ago. The increasing interest in congestion pricing in many cities around the world suggests that traffic problems are not lessening. The ever increasing relative cost of moving people would suggest that the size of the "unit of production" should be moving away from the large factory, so dominant for the last two centuries, towards more home based production, as in the period before the industrial revolution. Joel Mokyr does however add a cautionary note; "... it seems clear that the movement away from factory settings will eventually run into diminishing returns and that the locus of work will remain a mixture of work at home and work away from home". (Mokyr 2002: 155).

Brynjolfsson (1994) also sees advantages in firms being small when information is important in production. In his view " ... small firms are likely to have an advantage in providing incentives, not only because it is likely to be easier to separate out and contractually reward the individual contributions, but also because agents in smaller firms have stronger incentives to make uncontractible contributions as well. ... When it is important to provide incentives for the application of information in ways that cannot be easily foreseen and incorporated into a contract small firms have a relative advantage over large firms." (Brynjolfsson 1994: 1654).

There are of course other factors at work in determining firm size. Its now easier to set up new small companies: finance is more available, costs of equipment are lower and the burden of red tape has in many countries been reduced. But all of this seems to mean the mid-sized firm in on the way out.